Litigation Finance – An Alternative Strategy Event
n Tuesday, July 17, CFA Society New York hosted Litigation Finance – An Alternative Strategy Event
. The event was organized by Mark Sullivan, CFA, Managing Director and Partner, Stonehaven, LLC.
The event explored the growth of the litigation finance market and the investment opportunities that are associated with it, presenting an extensive and in-depth discussion that delved into the origins of the litigation finance market, the size of the opportunities and market dynamics.The structure of the event was on two panels:
Panel 1: Framework of Litigation Finance
This panel established the market size, its history, market participants and the products that are typically available. The Panel was moderated by Philip Kessler, Partner, Hoffman & Kessler and included the participation of:
- Michael Rozen, President & CEO, TRGP Capital Management, LLC
- Jim Batson, Investment Manager, Bentham IMF
- Cindy Chen Delano, Senior Legal Analyst, Whitebox
Based on the panelists view, the market is derived from the need to finance litigation costs from the plaintiff side. The legal costs of suing are very high, in particular when suing a corporation, which typically has staffed lawyers and the ability to dedicate a lot of resources to defend itself. This has been solved in part by some law Firms that work on contingency basis, using their Firm’s capital to fund the process. The risk is that is a binary outcome: you can have an unfavorable decision and then having to write off your own (and pay the other party expenses).
Because of the uncertain outcome, the best law firms don’t want to take cases where collecting fees is contingent. However, that means that they are missing a lot of good cases that they can’t fund. This is the opportunity for litigation financing. The financier will usually work together with the law Firm to review the cases and their chances of successful outcome to decide if they want to participate as funding party.
According to Batson, the litigation finance market started originally in Australia in the 1950s, moved subsequently to the UK and then to the US, where it started to shape up starting in the 1990s. This coincided with the surge in the size of claims and the increase in class action cases, which typically required a financier. Since then, in the US, the market has become well established, it is very technical and there are large sums of money available for financing. Still, there is currently more demand for financing than capital for financing, which allows for good returns to the investor.
Panelists had different views of the size of the market. The base number comes from US litigation costs which according to Rozen is in the tens of billions of dollars. Only 30% of those costs are currently being funded by a 3rdparty. Another way to estimate it -by Delano- is by settlement value, which he thinks is between $50-100 bn in the US only. Estimates in other jurisdictions are harder to come by.
Financiers have first claim on the settlement proceeds. They typically agree on a certain multiple return with the plaintiff and the law Firm. If the settlement is not enough, the law Firm or the plaintiff may go home empty even if they win. As a good market practice, litigation financiers try to participate only in cases where the potential settlement is 8-10x the amount estimated to be invested (based on the Law Firm fees which drives the expense estimation). This allows for sufficient money to be split between the plaintiff, the Law Firm and the financier. Rozen estimates that this ends up working out in a multiple of 3x the return for the funding Firm
In the opinion of Delano, the perfect case to fund is the one that has the greatest certainty that it will end up with a favorable outcome. Funding firms compete for those and the multiples sought after contract a little bit. Finally, multiples on the money invested are set up upfront. The unknown is the time that it will take to generate them, so IRRs can change depending on how long a case takes.
In the structure of litigation funding there are usually three parties involved: the plaintiff, the financier and the law Firm. In spite of being the main beneficiary of the settlement, financiers negotiate with the Law Firm that part of their fees are paid on a contingent basis only, in order to align their interests with them. Batson was of the opinion that there is also a delicate issue on the control of the lawsuit (i.e. can the suit be settled and who makes the decision). This is coordinated between the three parties but it has to be clear that the final decision rests with the client and not with the one funding. If this is not, it can open a pandora’s box where the entire relationship between the funding Firm and the plaintiff can be audited by the defendant, something that would be contrary to the concerted effort. Moreover, it could even lead to a situation where the financing agreement is deemed invalid and the financing Firm will not get paid, even in a successful outcome.
There are over 20 states that forbid the financing of lawsuits. In some of those that allow it, there are mandatory disclosures for some cases, but not for others. In general, where available the courts have not required anything about the funding party, but this may start in the future.
Another topic covered by this panel was asset diversification and risk minimization in the context of financing a portfolio of lawsuits. These are some of the key elements in diversifying risks in litigation finance:
- Fund multiple Law Firms
- Fund multiple different cases
- Limit uniform cases (i.e. patents can only be 20% of the maximum)
- In the case that the funding company is also financing another defense case with the same law Firm, there could be a natural hedge and there would be the willingness to charge a lower fee.
Panel 2: Litigation Financing Solutions
This panel focused on the different structures for investing in Litigation that exists in the market currently and was moderated by Justin Brass, Managing Director, Jefferies, LLC and included the participation of:
- Owen Cyrulnik, Managing Principal, Curiam Capital
- Boaz Weinstein, Principal, Lake Whillans Litigation Finance
- John Lazar, Director, Burford Capital
Lazar started by painting a panorama of the decision to fund a case or not. They believe that it only makes sense to fund a case where at least $2m will be invested. To collect $2m, the target settlement then starts at $20m. Boaz believes that few Firms go beyond $15m in funding per claim. In those cases above that amount, you will likely syndicate the financing among several Firms. Interestingly, Hedge Funds participate as investors in some of these settlements and have been marginal players.
Cyrulnik presented an interesting case of a Settlement with Argentina government where part of the funding was securitized in a daily trading vehicle. Although it was not very well traded, it appreciated as the litigation was moving favorably to the part that had been funded. This may become a trend in the future, what could bring more participants to the market and even to the creation of derivatives on these instruments.
The largest Litigation Finance Firms used to operate out of their balance sheet, but now they have become in essence Private Equity managers, managing the money of other third parties to be invested in Litigation Finance. A fund can be anywhere from $50-150m and they are approximately 3 years investing, 3 years harvesting structures. From that point of view, in analyzing a fund, its essential to review: terms of control, incl. termination rights; price, term, structure, waterfall; reps & warranties, remedies in case of breach. Its also important to estimate the possibility of a counterclaim, as it may eat into the proceeds of the settlement.
Lazar painted out how the litigation deals are usually sourced: direct marketing, outreach, public deal flow and Brokers. The last ones have become an amazing force to find potential clients and the most appropriate financier. Still, many of the litigation financers have deep established relationships with Law Firms that become their main source of new cases. Another type of Firm that participates in this market are discounters: they will provide the Firm with immediate access to the proceeds of a favorable judgement, after a certain discount rate. In some instances, the funding is general to an entire Law Firm on proceeds from any of a number of cases, this of course is cheaper than one on one, but carries less risk.
Lastly, the panel stressed the importance of transparent dialogue between key parties of a deal: law firms, plaintiffs, defendants, and funders. Having transparent dialogue sets realistic expectations and minimizes risk for all parties.
The panel ended with a short Q&A session, followed by closing remarks that were delivered by Kris J. Thiessen, CFA, CAIA, EA, Founder and Managing Partner, Helix Management. The event culminated with a catered networking reception and cocktails for the over 75 attendees at the CFA Society New York office. The Litigation Finance was a comprehensive and educational outlook on the growth and nature of this market as well as the risks and challenges involved. We deeply thank our speakers, CFA Institute, organizers, and attendees who helped make the event a success.